AT&T-Time Warner Legal Analysis: How the Judge Came to Approve a Mega-Merger

U.S. District Judge Richard Leon examined the government's theories and finds vertical mergers "are not invariably innocuous," but faults the Trump Justice Department for presenting insufficient evidence demonstrating why competition in the media industry will be substantially lessened.
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AT&T chairman and CEO Randall Stephenson (left) and Time Warner CEO Jeffrey Bewkes

The government's first legal challenge to "vertical integration" in decades presented U.S. District Court Judge Richard Leon with what he calls a herculean task — figuring out the future for the media industry.

During the six-week antitrust trial in March and April where the Justice Department argued against the $85 billion merger between AT&T and Time Warner, there were plenty of naysayers who wondered whether the government truly had a winning strategy. They turned out to be right, but in the end, it was still Leon's chore to put it all together and render an opinion that would withstand the test of time.

"If there ever were an antitrust case where the parties had a dramatically different assessment of the current state of the relevant market and a fundamentally different vision of its future development, this is the one," he opens his 172-page opinion. "Small wonder it had to go to trial!"

In examining whether or not to block the merger between one of the nation's biggest telecoms and the owner of HBO, Warner Bros. and CNN, Leon examined the evidence and dueling arguments over whether AT&T's proposed acquisition would be likely to substantially lessen competition under Section 7 of the Clayton Act.

The fate of the merger requires context, and the one pointed to by government lawyers was a history of television channel "blackouts," AT&T's acquisition a few years earlier of satellite TV giant DirecTV and what would be the conglomerate's newfound power after owing Time Warner's so-called "must have" television content including Game of Thrones, the NBA playoffs and Anderson Cooper 360. Meanwhile, the defendants pointed to an industry being transformed by high-speed internet access and disrupted by massive competition from newer digital entities like Netflix, Amazon and Hulu (vertically integrated companies that both produce and distribute content) plus Facebook and Google now giving everyone a run for their money in the advertising market.

In his ruling, Leon runs through the structure of the video programming and distribution industry — discussing everything from affiliate fees to how advertisements are sold on television. He outlines trends including the rise of over-the-top video content services, as well as cable subscription cord-cutting, and clearly seems swayed by the sweep of revolution in the air as he quotes Bob Dylan's observation, "You don't need a weatherman to know which way the wind blows."

Leon realizes that this is no ordinary case.

"[T]he 'familiar' horizontal merger playbook is of little use," writes the judge, referring to mergers between direct competitors. "That is, of course, because the proposed transaction between AT&T and Time Warner is a vertical merger — i.e., one that involves firms that do not operate in the same market and thus produce[s] no immediate change in the level of concentration in any relevant market. The parties therefore agree that in this case there is no short-cut way to establish anticompetitive effects, as there is with horizontal mergers."

Since the government hasn't challenged a vertical merger in decades, and given how executives throughout corporate America will be reading his guidance carefully, every word in Leon's decision matters. The judge accepts that vertical mergers "are not invariable innocuous" and says his analysis over AT&T-Time Warner must turn on "case-specific evidence," whether the government has established that the merger is likely to substantially lessen competition "in the manner it predicts."

The judge turns to each of the government's three main theories on why the merger represents competitive harm.

First, and most important, there's the proposition that Turner will be able to make extortionate fee demands on cable and satellite distributors for its "must-have" content. This concern arises because AT&T owns DirecTV, which could make the telecom more willing to tolerate blackouts, at least in the short term, if a licensing deal can't be reached with AT&T's rivals. In turn, after bowing to demands, distributors would then pass on price increases to their subscribers, resulting in what the government claims would be hundreds of millions of dollars more in annual consumer payments. The theory is knocked by the defendants as ignoring "meaningful real world evidence" plus efficiencies that could actually save consumers money.

"In evaluating these competing contentions, the Court unfortunately does not have the luxury of looking to judicial precedents applying the increased-leverage theory in the context of a Section 7 challenge to a vertical merger," notes Leon. "Indeed, the Government has not pointed to any prior trials in federal district court in which the Antitrust Division has successfully used this increased-leverage theory to block a proposed vertical merger as violative of Section 7. ... Thus, in this matter of first impression, I must determine whether the evidence adduced at trial is sufficient..."

He concludes it isn't sufficient, especially given the negative consequences of blackouts for programmers and a record showing that there has never been a long-term blackout of the Turner networks.

"Notably, under the theory, the Government does not allege that a post-merger Turner would be incentivized to start actually engaging in long-term blackouts with distributors," writes Leon. "That is so, as Professor Shapiro [the government's economics expert] concedes, because withholding Turner content would not be 'profitable' to the merged entity given the attendant losses in significant advertising and affiliate fee revenues. In other words, and in contrast to a prevalent theory of vertical merger antitrust harm, Turner will not 'foreclose' downstream distributors from accessing content."

As for the concern that the prospect of blackouts would at least cushion Turner's downside position and put the company into better bargaining position with cable and satellite providers, Leon just doesn't see enough objective evidence to support such a theory of harm. He won't even accept the government's position that Turner's content is literally "must have," nodding to what executives like Dish founder and chairman Charlie Ergen have said over the years. The judge also doesn't see much in defendants' statements — everything from past regulatory filings to internal emails — to provide a substantial foundation for the theory that increased bargaining leverage will really result in increased distributor and consumer costs, and ultimately, lessen competition. And if there's still any doubt, Leon points to the history of vertical integration (News Corp. once owned part of DirecTV; Time Warner was once married to Time Warner Cable; Comcast acquired NBCUniversal in 2011) as not providing significant evidence of enhanced leverage from owning both a distribution channel and content supply as affecting affiliate fee negotiations or pricing.

Judge Leon doesn't spend nearly as much ink in his lengthy ruling addressing the government's other big theory that AT&T may use the merger to hinder the growth of virtual MVPDs, those over-the-top live streamers of skinny bundles of television programming (Dish Sling, Sony Playstation Vue, Google's YouTube TV, etc.). 

"Industry trend-lines point toward increased video consumption in the future — and AT&T aims to ride these tailwinds," he writes. "Right now, AT&T is working to develop fifth-generation wireless, which will drive video consumption even more. And AT&T views mobile consumption of video, including through virtual MVPDs, as a critical part of its post-merger future. Notably, the benefits associated with AT&T customers accessing virtual MVPD content continue to accrue even when they use DirecTV Now's competitors like Sling and YouTube TV. All of this gives the combined entity even more reason to distribute Time Warner content as broadly as possible in order to encourage the proliferation of virtual MVPDs."

He then quotes AT&T chief Randall Stephenson as calling the merger a "vision deal" while shrugging off the government's evidence (e.g. friction caused a few years ago when Turner content was licensed to AT&T's competitor virtual MVPDs) and big fears (e.g. tacit coordination between AT&T and Comcast to slow down technological progress).

Finally, Leon also takes apart the government's third theory that AT&T would hold back rivals from using HBO as a promotional tool to win customers. He says the theory "conflicts with HBO's business model, which remains 'heavily dependent' on promotions by distributors" since it has no advertising. He adds the government has failed to establish that HBO promotions are "so valuable that withholding or restricting them will drive customers to AT&T."

In the end, this "epic battle" (as the judge puts it) wasn't a close one, but it nevertheless required months of preparation, weeks of testimony and ample thought from all those involved, including reporters, analysts, a government trial team led by Craig Conrath, a defense legal team led by Daniel Petrocelli and, finally, the judge.

In concluding remarks, Leon strongly hints he won't stay the merger pending an appeal because he doesn't see the government as likely to win — one of the prongs in the would-be analyis — and doesn't think it would be fair to allow the government to accomplish its goal of blocking the merger even indirectly. (AT&T and Time Warner gave themselves a deadline of June 21 to complete the merger and any extension would have to be negotiated.)

The judge also offers the advisory exclamation that "the temptation by some to view this decision as being something more than a resolution of this specific case should be resisted by one and all!"

"The government here has taken its best shot to block the merger based on the law and facts, and within the time allowed," he adds. "The defendants did their best to oppose it. The Court has spoken."